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June 27, 2012

[While Mongolia may be blessed by geology, it is cursed by geography. Landlocked between China and Russia, its three million people face a geopolitical quandary: Every path to prosperity leads through their mighty neighbors’ territory. And Moscow and Beijing intend to make Mongolia pay dearly for the privilege.]

By Dan Levin

TAVAN TOLGOI, Mongolia — “All you need to mine here is a shovel,” said an awe-struck Indian investment manager as he stood behind a barrier, along with dozens of international mining industry executives and other eager investors, gazing at the immense coal pit gouged out of the rust-colored earth below.

Coal may have lured the foreigners to this stretch of the Gobi, but that is just part of the buried treasure to be found now that this nation of livestock herders has started digging in earnest. Mongolia has not only enough coal to fuel China’s huge demand for the next 50 years, but also vast troves of copper, gold, uranium and other minerals the world covets.

While Mongolia may be blessed by geology, it is cursed by geography. Landlocked between China and Russia, its three million people face a geopolitical quandary: Every path to prosperity leads through their mighty neighbors’ territory. And Moscow and Beijing intend to make Mongolia pay dearly for the privilege.

That reality is abundantly clear here at Tavan Tolgoi. Beneath the earth lies the world’s largest untapped coal deposit, only 140 miles from the Chinese border. By one measure, the most practical solution would be to work exclusively with the Chinese, since nearly all the coal will be hauled there anyway.

Mongolia, however, has other ideas. Fearing that China may gain undue political influence, the government has spent years in a diplomatic tap dance over who will get to develop an estimated 900-million-ton portion of the deposit, much of it prized coking coal essential to making steel. The two main bidders are Shenhua Energy, a Chinese state-owned enterprise, and Peabody Energy, a multinational mining giant from St. Louis. Filling out the mix are a Russian-Mongolian consortium and companies from Japan and South Korea.

Long a major donor and prime diplomatic ally, the United States is pushing hard on behalf of Peabody, and observers say the future of Mongolian-American relations hinges in large part on what happens in the final deal. China, eyeing the maneuvering by the Obama administration, is increasing the diplomatic pressure as well.

But even as the scramble for resources underscores the growing rivalry between Washington and Beijing for influence in Asia, infighting in Mongolia’s bare-knuckle democracy, expected to reach a boiling point in parliamentary elections on Thursday, has thrown into turmoil efforts to forge an international mining agreement over Tavan Tolgoi.

“We’re a small country sandwiched between two elephants,” said Puntsag Tsagaan, a presidential adviser on mining. “We can’t go to war and fight, so we have to secure our economic growth through diplomacy.”

That kind of approach, however, is a tough sell for Mongolia’s rowdy nationalists, who have grown increasingly powerful in the two decades since the country broke free from the Soviet orbit. And they have much to complain about. The taint of corruption clings to every government deal with a world power or multinational corporation. Horror stories about pastureland fouled by mining are staples of the Mongolian press, alongside tales of herders abandoning their flocks to work the mines. Most Mongolians have enjoyed little of the riches extracted from their land.

Which is why foreign ownership of their country’s mineral wealth most riles Mongolians. Many are still upset at a 2009 deal awarding Ivanhoe Mines of Canada a 66 percent share of Oyu Tolgoi, the world’s largest untapped deposit of copper and gold. Ivanhoe, whose majority owner is Rio Tinto of Australia, is hoping to open the mine next year after spending more than $4 billion on its development.

Parliamentary candidates have made it a major campaign issue, vowing that much more of the profits will stay in Mongolia this time. Lawmakers have already announced that every Mongolian will receive shares of a multibillion-dollar initial public offering for the state-owned company that runs another part of the Tavan Tolgoi coal deposit.

But without more foreign help, the mines will remain untapped. Mongolian officials say the deal on Oyu Tolgoi — which took six years of painstaking negotiations with just one company — was simple compared with handling the hornet’s nest of competing agendas over Tavan Tolgoi’s coal.

Mongolians know they are vulnerable to Beijing’s near monopoly over the country’s exports, being forced to accept an average of 30 percent less than their commodities are worth on the open market, analysts say. “If China closed the borders, we would starve to death,” said Zolboo Bataa, 34, an account manager for a multinational construction equipment company in Ulan Bator, the Mongolian capital.

Beijing has also wielded its clout to exact political vengeance. In 2002, China shut its borders with Mongolia during an official visit by the Dalai Lama, the Tibetan spiritual leader; last year, Beijing pressed the government to cut short another visit. Such tactics make Mongolians fear that China might swallow up not just their economy but also their sovereignty.

“Mongolians see what’s happening in Tibet and Xinjiang,” said a local banking executive, who asked not to be identified because he does business with China. “They know the Chinese don’t have their best interest at heart.”

That anxiety turned to panic in April, when news broke that Ivanhoe planned to sell its majority share of a coal mine to a Chinese state-owned aluminum manufacturer. Parliament finally passed long-languishing legislation that prohibits foreign state-owned enterprises from buying up a majority of Mongolia’s “strategic” industries unless granted prior government approval.

That law marks the latest step in the complicated political choreography aimed at appeasing a rising nationalist fervor while encouraging foreign investment.

To offset its reliance on China, Mongolia has sought to expand cooperation with the United States, in what the government calls the “third neighbor” policy. The United States has provided hundreds of millions of dollars in aid to Mongolia, though the bilateral teamwork goes beyond the financial. Washington doles out thousands of visas to Mongolian students, and Mongolia has dutifully sent troops to Iraq, Afghanistan and even Alaska, where they train with the National Guard.

Last year, the Mongolian president, Tsakhia Elbegdorj, met with Mr. Obama at the White House and dined with the first lady. Later, Vice President Joseph R. Biden Jr. visited Mongolia, holding talks with the prime minister and calling his host country a “shining example” of democracy.

The Obama administration is also focusing on economic development. “We want to be a part of the balance of trade,” the United States ambassador, Jonathan Addleton, said in an interview, noting that his country had significantly increased its exports to Mongolia.

But the United States is also looking for a bigger return. Those briefed on internal discussions say that Washington recognizes that Mongolia will dole out its resources among various interests but insists that Peabody receive the lead role in developing the new portion of the coal mine.

“Tavan Tolgoi is the only project in Mongolia in which the U.S. has a dog in the hunt,” said one American executive based in Mongolia. “What the Americans are saying is, ‘We can’t be your best friend and primary third neighbor if all the goodies go to China.’ ”

One reason Ulan Bator may be procrastinating is that any decision will undoubtedly leave some of the players feeling shortchanged. When information about the negotiations leaked out last year, revealing that Peabody and China were destined to be the primary winners on Tavan Tolgoi, Russia, Japan and South Korea were outraged. As the complaints mounted, the Mongolian government, desperate to control the geopolitical damage, shut down negotiations until after the elections.

“We’re trying to make a deal with world powers that’s in line with our national interest,” Mr. Elbegdorj said in an interview. “Reaching a consensus is complicated.”

To further help break Beijing’s grip, the government has embraced a $7 billion railroad expansion through Russia that will give Mongolia direct access to more customers.

“Mongolia is without a doubt getting more respect from world powers,” said John Johnson, an executive based in Beijing with CRU, a mining consultancy. “Because it’s got something everybody needs.”